Home Loans from Family and Friends
More people are turning to loved ones to secure loans for the purchase of a new home. Everyone legally has the option to borrow from family or friends if both parties are willing. If you handle loaning money correctly, everyone can end up winning.
These loans are often referred to as private home loans, a personal loan or an intra-family loan. They are not as uncommon as you might imagine. They are almost the same as a mortgage that you could get from the bank or another traditional lender in many respects.
These types of loans are common when:
- You have trouble securing a loan from a bank
- You have difficulty saving for a down payment
- You don't want to get involved in the mortgage programs that banks offer
- It seems easier than using a bank or payment program
Table of Contents
- What is the Private Home Loan Process?
- Benefits for Borrower
- Benefits for Lender
- The Paperwork for a Private Loan
- After You Get the Private Loan
- Setting Up a Private Loan?
What Does a Private Home Loan Process Look Like?
The process can be flexible to you and your friend or family member's (called a private lender below) needs. As an example, let's say you have a private loan for $50,000 for a home. Just like with more traditional loans and mortgages, you will probably have to agree to:
- Sign several legal documents that go along with the private home loan (read more information on the paperwork involved)
- Make steady payments each month until the loan is paid off
- Example: $1,000 a month for 50 months, or just over four years.
- A set interest rate and pay the interest each month
- Example: a 3.9% interest rate which brings your interest to $39 a month and brings your total payment to $1,039 per month
- Over time this means you will pay $51,950 total for the loan because $1,950 is in interest
- Your private lender holding a lien on the home you buy
- Your private lender demanding "payment in full" if you fall behind on payments
- Your private lender foreclosing on your property (just like a bank) if you fall behind on payments
- Your private lender asking you to sell the house to make good on the outstanding balance of the loan
Like with a bank, you would also have rights against the private lender as well. When borrowing from family or friends, your lender could not ask for full payment without just cause (not if, for example, you missed your grandmother's 80th birthday).
Benefits of a Private Loan: For the Borrower
There are several benefits that you may get by opting for a private loan that you may never get by going to a bank. You may be able to get the loan you need at a lower interest rate than you could have received from a bank. In turn, the people you borrow from may be able to get an interest rate better than even the best savings account can offer.
These benefits could include:
- Low-Interest Rate: Banks are in the business of making money, and to this end, you are often at their mercy if they wish to charge a high mortgage rate. Because of the nature of private loans, however, your private lender may "fix your loan" at a lower rate than you would ever see coming from a bank.
- Payment flexibility: Unlike banks and other institutional lenders, a private lender will most likely allow you to vary your payment schedule depending upon your circumstances. Also, a private lender would probably not impose penalties for things like early repayment, whereas banks commonly engage in the practice.
- Federal tax deductions: You will be able to deduct from your federal taxes while borrowing from family or friends. You can take the same tax deductions for your private loan as you would for conventional loans.
Benefits of a Private Loan: For the Lender
In addition to benefiting the borrower, a private loan also bestows benefits to the private lender. These benefits could include things like:
- A better rate of return: Private lenders can offer the borrower an interest rate that is between the highest savings-account interest and the lowest mortgage rate. By doing this, everyone wins. The borrower gets a great interest rate, and the lender's money earns more than it would from sitting in a bank account.
- Steady income: Like conventional mortgages, private loans are paid over a period of time. Because of this, the lender has the opportunity to have a steady source of income that is reliable and dependable.
The Paperwork for a Private Loan
If you have come to an agreement with a friend, family, or loved one to have them finance all or a portion of your home loan, you should treat it just as a bank would. To this end, you should draw up the necessary paperwork, such as a promissory note and various documents that go along with a mortgage. Also, you may want to think about putting down a proposed repayment schedule in writing.
- Promissory note: Commonly called a mortgage note. This is a binding document signed by both you and your lender. It says you agree and promise to repay the loan under specific terms. The terms that must be included in this note are:
- The interest rate
- The loan principal
- Payment dates
- The period between payments
- Any penalties that may be imposed for late payments or non-payment, such as requiring full payment of the loan if certain conditions occur.
- Mortgage: Also known as a deed of trust, the mortgage document is the legally binding document that secures the promissory note. This gives the lender the legal authority to foreclose on the property if you do not pay off the entire loan, plus fees and interest, within a specified time. The mortgage document needs to include:
- The recognized owner of the property
- A legal description of the property
- The borrower's responsibility to pay off the promissory note
- The borrower's responsibility to maintain insurance
- Any regulations to keep the property in good condition
- Rules regarding if the lender may ask for full payment on the loan immediately if you, as the borrower, fail to comply with the mortgage
- Repayment schedule: Although it is not legally required, it is still a good idea to put down in writing the agreed-upon repayment terms. This will help avoid any unnecessary strain between you and your private lender.
After You Get the Private Loan
Just like with a traditional loan agreement, if you run into problems in paying off the loan, you should be sure to contact your private lender as soon as possible. Because your lender will be family or a friend, you may be able to work out a solution, such as forgiving some payments on the loan. It would be best if you tried not to take advantage of this in excess, however, as it may place significant strain upon the relationship between you and your lender.
Setting Up a Private Loan? You May Want to Speak With an Attorney
Buying a home is the biggest transaction you will likely make in your lifetime, and while it's considered a "good" form of debt, it's still a huge commitment. You may encounter multiple legal issues when closing on a home sale or securing financial resources, even if you're able to procure home loans from friends and family. Consider speaking with a real estate attorney to make sure your private loan terms protect your interests.